Mark Twain once said that history does not repeat itself, but it does rhyme. As the world bears witness to the Cypriot crisis, it is worth examining similarities to Argentina’s own crisis just over a decade ago and rehashing the lessons learned from that experience.
Once held as the poster child of neoliberal economic reform, by the year 2001, poor management in great part led to Argentina’s external debt to surpass 62% of GDP, and, despite radical austerity measures with wide social consequences, interest rates spiked, real GDP shrank, unemployment skyrocketed, and the country’s credit ratings plunged.
In complete stagnation, Argentines, fearing an economic collapse and possible currency devaluation, ran on the banks and began withdrawing cash, converted Argentine pesos to foreign currency, and transferred savings to foreign accounts.
Convinced that the capital flight would drain the financial system, the government froze all bank accounts and only allowed small cash withdrawals in local currency.
The ensuing political and social turmoil culminated with five presidents coming and going in a matter of weeks, Argentina defaulting on $102 billion in debt, and currency liberalization and imposed conversion guillotining bank savings.
Although the social and economic devastation was manifold –with more than half of Argentines living under the poverty line, Argentina gradually recovered as its export-driven economy expanded by almost 9% in the year following the crisis after shrinking by nearly 11% just the year prior.
While the Cypriot crisis today differs significantly from that of Argentina’s more than a decade earlier, it does, however, bear striking similarities with potentially devastating consequences.
A victim of mismanagement and the Greek debt crisis, the Cypriot economy has contracted since 2009, and its credit ratings have been slashed as unemployment, interest rates, and private and public debt (now at 87% of GDP) have soared.
Already, Cypriot banks are showing signs of growing insolvency: they have borrowed some €9 billion from their Central Bank and were on “holiday” for almost two weeks to prevent a bank run.
For a small country whose economy heavily depends on its banking sector, the potential implications of the crisis are stark.
Unlike Argentina, however, which was abandoned by international creditors despite years of easy access to credit, Cyprus has managed to stay afloat with the help of a €2.5 billion Russian emergency loan in 2012 and a €10 billion IMF/EU assistance package this past week.
But under the IMF/EU loan, the island nation’s largest troubled banks must now impose, like Argentina did, a haircut to savings over €100,000 in part to show European taxpayers that they are not, in essence, bailing out Russian money launderers with sizable deposits in Cyprus.
Meanwhile, much like Argentina did, Cyprus has imposed strict capital controls to stem a bank run in contravention to the free flowing monetary tenets of the euro zone, including, limiting daily personal withdrawals, business transactions and cashed checks, imposing limits on foreign payments and transfers, and eliminating the termination of fixed-term deposits before maturity.
Capital controls, however, also erode depositor confidence and constrain lending and economic activity at a time when it desperately needs a jolt.
In response, Cypriots have turned to the streets and Finance Minister Michalis Sarris resigned this week after coming under public fire. The political and social reverberations are just beginning to show.
But should capital controls be lifted in response to popular pressure, capital flight will collapse the banking system, as occurred in Argentina.
The Argentine example would suggest that Cyprus restructure its debt and drastically change its monetary policy to restart its economy. But unlike Argentina, Cypriot monetary policy is dictated by the European Central Bank, and President Nicos Anastasiades has stressed Cypriot commitment to the euro.
Although IMF/EU help has mitigated the threat of a financial collapse in the short-term and given Nicosia some breathing room to restructure its banks without having to exit the euro, the Argentine crisis shows that the unpredictable measure of confidence in a country’s banking system is hard to recover once lost.
In other words, why would anyone choose to keep their money in a Cypriot bank in the face of instability, capital controls, and imposed savings losses?
For a country built on banks, depositor confidence is what upholds the Cypriot economy, and for all our sake, let us hope that the eroded confidence is contained to just Cypriot banks.
Expectations for Cyprus are dire. Like Argentina, should capital controls be lifted, austerity measures, and deteriorating depositor confidence will drive capital flight despite foreign financial assistance.
Although what is to come for Cyprus is yet uncertain, the Argentine example is an awful warning of what may happen should Nicosia and the EU fail to revive the Cypriot banking system.
An Argentine-American, Alejandro M. Sueldo lived through Argentina’s crisis.
